Large Cap Value Outlook for Q3 2023

Slowing economic growth combined with the artificial intelligence-binge has led to a confluence of events that has sent investors chasing mega cap tech stocks, with their perceived profile of safety with a new and exciting AI twist.

The outsized influence of a few strong-performing mega cap equities has the potential to leave the stock market vulnerable to a quick unwind if the tech sector suddenly falters, as it did in 2022. Poor relative and absolute performance of equities within sectors including crude oil, regional banks, transportation, retail, and industrial metals imply reason for concern about impending economic weakness.

Profit margins in numerous sectors are under pressure due to a slowdown in demand coupled with negative operating leverage resulting from dynamics such as rising wages and interest expense. This has led to a lower level of anticipated earnings that has yet to be fully discounted by the stock market, despite a more cautious tone in corporate guidance.

Challenges to consensus earnings expectations

We believe investors still need to recalibrate EPS growth estimates lower. We highlight the risk that profit estimates are still overly optimistic, especially if the economy enters a recession, as many anticipate. Downward revisions to bottom-up EPS estimates have been particularly sharp (and imply no growth), while top-down aggregate estimates for the forward 12-month S&P 500 Index target assume earnings will rise. Both cannot be true. In a typical recession scenario, consensus estimates fall significantly.